AD formula
C + I + G + Xn
Nature of relationship between variables of AD curve - price level vs. real GDP
Downward sloping; as price decreases, people are willing and more able to buy more output
3 rationale for slope of AD curve
Wealth/real balances effect; interest rate effect; net export effect
Wealth/real balances effect
When prices fall, the purchasing power of money increases, so consumers feel richer + spend more
Interest rate effect
Lower prices reduce the demand for money, which lowers interest rates + encourages borrowing for consumption + investment
Net export effect
When domestic prices fall relative to foreign prices, exports rise and imports fall → increase in total demand for U.S. domestic goods
Determinants of AD
Consumption (household spending); investment (firms spending on capital goods); government spending (public spending); net exports (exports - imports; reflects demand for domestic goods)
Consumption function determinants
Wealth; expectations; household debt; taxation
Investment demand curve determinants + shape
Expectations; changes in GDP; price of capital; change in business taxes + downward sloping
SRAS curve shape + reason
In the short run, firms respond to higher prices by producing more output
SRAS - sticky wages + input prices theory
Output prices adjust faster than wages, so rising prices increases profits + output temporarily
Profit maximization
Firms expands production when higher prices make selling more profitable
Determinant shifters of SRAS
Labor; capital; natural resources; tech; productivity; expected price level (higher expected prices raise wages + costs); govt policy
LRAS potential output
This is the economy’s full-employment level of real GDP
Determinants of LRAS
Labor; capital; natural resources; tech; productivity
Positive demand shock
AD shifts right; increased spending raises output + prices; creates inflationary gap (output exceeds potential; puts upward pressure on wages)
Negative demand shock
AD shifts left; decreased spending decreases output + prices; recessionary gap (output falls below potential; unemployment rises)
Positive supply shocks
SRAS shifts right; lowers production costs; increases output + lowers prices
Negative supply shocks
SRAS shifts left; higher costs reduce output + raise prices simultaneously
Stagflation
Inflation + falling output; rising unemployment + rising prices
Recessionary gap
High unemployment; wages fall; SRAS shifts right
Inflationary gap
Low unemployment; wages rise; SRAS shifts left
Self correction from recessionary and inflationary gaps
Flexible wages eventually restore long-run equilibrium without government intervention
